Inexpensive and reliable fare that is freshly prepared, portable and ready on demand – that’s what makes quick service restaurants like Wimpy, Panarotti’s and Milky Lane successful. People have been looking to escape the kitchen in favour of these establishments for quite some time.
The first hamburger chain was White Castle, founded in the US in 1921 by Walter Anderson and Billy Ingram. Featuring a grill and a fryer that was open for customers to see, the restaurants were designed to build confidence in the notion that low cost could coincide with high product quality. Consumers have never looked back.
In South Africa, where the concept of quick service franchises was introduced in the 60s and 70s, the quick service restaurant industry appears well positioned for gradual growth in the first half of 2012, despite the sluggish economy.
“Operators have managed to improve results in the last few months on the back of steady if modest traffic improvement and the consequent rise in sales,” says Gregory Binstead, general manager of Maxi’s. “Consumers are becoming more confident and starting to increase their discretionary spending. At the same time, operators are also focusing on containing costs and offering customers value for money. There’s no doubt that popular brands have the potential to drive growth.”
Binstead stresses that consumers definitely cut back in the past few years. But now that they are starting to spend again, they are fighting for quality of product, value for money and great service. Despite the challenges in the industry, there are many successes, with some operators and franchisees seeing up to 30% growth year-on-year. He notes that in the restaurant sector, the franchise model reduces the volatility in earnings and increases cash flow generation.
The Ideal Franchisee
“You don’t have to have a specific personality type to work successfully in the quick service restaurant sector, as customer service and relationships with employees are of paramount importance in any business,” says Vera Valasis, executive director of the Franchise Association of South Africa (FASA). “However, you should be able to deal with customers and staff effectively. If you prefer to sit in a back room working on your computer, then a business in this sector is not for you.”
Like most quick service franchise systems, Maxi’s has specific requirements when it comes to identifying ideal franchisees. Binstead suggests asking yourself 12 key questions:
- Are you a hands-on operator?
- Are you willing to work long hours?
- Are you prepared to protect your brand?
- Are you service and people orientated?
- Are you willing to go the extra mile for your customer and your brand?
- Are you prepared to learn?
- Are you prepared to add value?
- Are you proactive or reactive by nature?
- Are you non-discriminatory?
- Do you understand the importance of national operational standards?
- Do you understand that increased involvement at store level is equal to increased profits?
- Do you have the prerequisite finances?
“In sit-down quick service restaurants, the owner is a key driver of success,” he says. “The personality of the franchisee helps to drive the brand. Customers like to eat at places where people know their name. At an over-the-counter venue, you may get away with employing a manager, but the same does not apply to sit-down venues where the owner should always be on-site.”
Avoiding Costly Mistakes
Binstead notes that some people buy into a franchise without realising the level of personal involvement and commitment that is required of them. An owner-operator sets the pace of the business and determines the energy level of the staff, which is why their presence is critical. To prove his point, he refers to manager-run restaurants as ‘damager-run’.
When it comes to reasons for store failure Binstead – who has many years’ experience in the franchise industry, says it results from mistakes that are common across the industry. “If you don’t believe that the success of the brand is your success, then this business is not for you. Franchisees sometimes make the mistake of buying non-licensed products because they are often cheaper. But cheaper is usually also inferior, which results in damage to the brand and ultimately the failure of their store.”
Mismanagement of funds is another issue. Cash flow, the total amount of money moving in and out of the business, is critical and affects the liquidity of a store. “Inexperienced franchisees who come from the corporate world, for example, can make the mistake of assuming that it’s okay for them to continue to earn a guaranteed income even though they are now operating in an entrepreneurial environment where money flowing out of the business must be kept to a minimum, especially in the early stages.”
He advises franchisees in the quick service restaurant sector to focus on cutting back where they can. “Because labour costs are so high, it can be very dangerous to throw lots of staff at problems. Hands-on franchisees know the importance of having the right number of people on site at the right time. During periods of the day when sales decline, such as mid-morning and mid-afternoon, staff should be clocking out and not sitting around idle. Many franchisees are going the mixed route where they have 30% permanent staff and 70% casual. This helps them to manage their fixed labour costs.”
This type of cost-containment is vital in a country where electricity costs have gone up four times in one year and rental increases have been as high as 15%.
Banks are more tight-fisted than ever and are doing their homework a lot more thoroughly when it comes to lending money to entrepreneurs. Many big brand franchisors have good relationships with one or more of the banks and may be able to assist franchisees when it comes to negotiating the best deal. But access to finance is by no means easy. “It takes twice as long as it used to take to get a loan approved and the process can take months,” says Binstead.
Valasis concurs. “Funding remains an obstacle to growth in the industry. Traditional funders are risk averse and require unencumbered collateral of at least 50% of the total investment which makes access to funding available to a small number of high-end individuals. Many quick service restaurants are expensive to set up so expansion at this level could be curtailed to existing franchisees wishing to expand within the same brand. There are some funding agencies that grant funds and in some instances give grant money to franchisees but the application process is cumbersome and time-consuming.”
Depending on the size of the outlet, a Maxi’s store costs between R1,8 million and R3 million, excluding VAT, working capital and landlord contributions. 50% of the total cost is required in cash. All new franchisees pay a joining fee of R100 000 excluding VAT for the rights to the use of the Maxi’s brand.
Costs include building, signage, in store signage and branding, point of sale equipment and computers, kitchen equipment, project design and management, shop fitting, kitchen smalls and opening stock, training, uniforms, and marketing, which includes an opening campaign and materials.
Working capital amounts to approximately R300 000 for a restaurant. This cost includes items such as stock, training, wages for staff while in training, provisions for rental and electricity deposits, and additional expenses such as legal fees and stationery.
A management fee of 6% of monthly net turnover is charged, as is a marketing royalty of 4% of monthly net turnover. These costs are in line with the industry average.
To manage the costs of running a restaurant, Binstead advises that ongoing audited income statements, and quarterly reviews and feedback are essential.
Beware the Risks
Any business is risky as there are no guarantees. But there are several risks specific to the quick service restaurant industry. Valasis lists them as follows:
- Incorrect site selection: What research has been done to verify the site viability?
- High set-up costs: Will you get a return on your investment?
- Overstated turnover and profit figures: Were the projections given based on a national average or actual turnovers of similar locations?
- Weak marketing: What is the marketing feedback from existing franchisees?
- Incorrect retail pricing policies: Is the product too expensive for the market in the particular location?
- Competitor activity: How many direct and indirect competitors are there in the vicinity and what is their unique positioning if any?
The Road Ahead
High labour costs, increasing fuel prices, spiralling electricity costs, credit unavailability, and weak income growth may weigh on industry profitability well into the future. According to a US report by Zacks Equity Research into the restaurant industry, restaurants globally have been trying to win back cash-conscious customers by revamping promotions, offering discounts and focusing on value-for-meal menus. The report notes that consumers continue to look for value, distinct dining experiences, as well as convenient and enhanced menu deals against a gradually improving economic backdrop.
“Some new trends have developed,” says Gregory Binstead. “For example, families are downsizing the meals they order for their kids and will often order one meal for the children to share. But the fact remains that people like to treat themselves and eating out is still one of the most popular activities. A great plus for the industry is the major growth in the number of black customers.”
It’s also becoming important to have a diverse menu. People are shopping for lighter meals and healthier options such as wraps and salads. Some restaurants in the quick service sector now cater for diabetics and vegans. But there’s no doubt that consumers still love quick service classics like burgers and fries. There’s also a growing demand for meat on the bone, chicken and steak in particular. Quick service restaurants like Maxi’s do especially well in the breakfast trade, which is very popular and remains a key driver of growth. Binstead adds that special promotions like pensioners’ days also help to drive traffic and are popular with cost-conscious consumers.
There are a number of regulations that owners have to comply with like labour law, the Liquor Act, the Competition Act, and the Consumer Protection Act (CPA). The definition of a franchise agreement in terms of the CPA is fairly broad and includes a full business concept franchise arrangement, as well as similar arrangements such as license, distribution and agency arrangements or contracts.
A franchise agreement must allow the franchisee to cancel a franchise agreement without cost or penalty within 10 working days after signing an agreement. The agreement must also describe the obligations of both the franchisor and the franchisee. Many of the requirements of the CPA with regard to franchising have always formed part of the standard franchise agreement.
Although international best practice has for many years dictated that disclosure should be given to franchisees, this has previously not been law in South Africa. FASA membership has for many years required that franchisors should furnish franchisees with a competent agreement, a compliant disclosure document, and an operations manual. The CPA regulations also set out requirements in relation to disclosure documents which are required to be furnished to franchisees, licenses, distributors or agents, at least 14 days prior to the signing of an agreement.
Ask the Right Questions
Binstead notes that the CPA provides excellent protection for franchisees, but the onus is still on them to do their homework. “If you are interested in buying a quick service franchise, talk to the existing franchisees and look closely at the disclosure document. Find out how long the company has been around, and choose established brands, particularly if you are new to franchising.” Fly by nights usually don’t have a fixed address, or an office address and a landline. They make promises of a quick buck without much effort. Their references may not all check out or they may supply false information.
Drivers of the quick service restaurant industry
The Zacks Equity Research report names four potential drivers of net income growth for the restaurant industry: unit expansion, same-store sales, cost-containment efforts and marketing tools.
- Unit Expansion: Emerging from a lacklustre economy two years back, most of the companies have accelerated their pace of restaurant openings. A relative recovery in consumer confidence has also encouraged companies to return to unit expansion. In fact, the companies are also exploring international markets.
- Same-Store Sales: The second driver consists of menu price increases and traffic counts. Many quick service restaurant operators have reported positive same-store sales and customer traffic growth in 2011. Growth in menu price has also accelerated.
- Cost-Containment Efforts: Some cost cuts have been achieved through integrated information systems, including point-of-sale, automated kitchen display, labour-scheduling and theoretical food cost systems.
- Marketing Tools: Social media as a marketing tool has taken the industry by storm. Many overseas operators rely on social media for promotion. They are likely to incorporate Facebook, online review sites, Twitter and blogs aggressively into their marketing mix going forward. Television advertising is also an important tool for promotion.
In general, franchisors guide and advise franchisees when it comes to suitable candidates, but the franchisee is ultimately responsible for hiring and firing staff. Probationary periods are therefore important and protect both the franchisee and the employee. Binstead recommends using recruitment and selection tools, particularly if you are not used to interviewing and employing staff. “The right recruitment process can provide security for the employer,” he says. “A new recruit may tell you that he has transport or lives close to the workplace when that is not true. Once you employ them, the problems start and they arrive late for work or not at all. A proper screening process can prevent this from happening.”
He also recommends a realistic job preview which enables prospective employees to spend time on-site and to determine whether they are right for the business and the business is right for them. This can save a lot of time and frustration for all involved.
Apart from following the requirements as stipulated in the Labour Act, you should also ensure that the people you employ in your business deal with customers in such a way that you, as a consumer, would be happy to be served by them. “Employees consistently need to treat customers like the little gold nuggets that they are, and not just be friendly on the day they feel good about themselves,” says Valasis. “More importantly, what do you do when an employee underperforms? Every day that they remain employed in your business more damage is being done to your investment unless you take swift and effective
action to correct their ineffectiveness.”